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January 9, 2014

The Biggest Threat to Firms That Serve the Wealthy

Among a wide range of findings, a Cerulli report says failure to engage heirs can threaten a wealth manager's asset base

As high-net-worth investors work with greater numbers of financial professionals and gravitate toward boutique-like service models, such as RIAs, multifamily offices and state-registered trust companies, the pressure is on providers to attract new wealthy clients.

In a wide-ranging report on the high-net-worth market, defined as clients with $5 million or more in investable assets, Cerulli Associates said that while new clients were crucial, firms courted danger if they failed to better engage the heirs of existing clients.

Heirs who are not adequately prepared for inheritances not only threaten legacies, but are the greatest threat to legacy providers’ asset bases when the fortunes are dispersed among numerous beneficiaries, Cerulli said.

The study found that HNW providers generally understood that engaging heirs now, including a spouse, increased the odds of retaining the inherited assets.

Many providers are trying to involve children at the outset of a new relationship, or persuading existing clients to invite their children. Others are designing boot camp programs to educate younger HNW investors on basic and advanced investing concepts, and to provide an opportunity to network with well-off peers.

These efforts give patriarchs and matriarchs the opportunity to explain the risks associated with accumulating wealth, and the risks that need to be hedged against when preserving wealth.

Cerulli said legacy providers, including wirehouses and bank trusts, should engage heirs to ensure they do not take cues from their wealth-creating peers, who are progressively shifting their assets to providers that offer greater levels of flexibility and control, including direct providers such as Fidelity and Charles Schwab.

It’s not surprising, then, that 56% of all asset managers surveyed by Cerulli considered the HNW market more appealing than other business lines because of investors’ sophistication.

Another 53% found the market more attractive because of the various vehicles used, and 50% liked the long hold periods.

Less attractive aspects of the HNW market included a time-consuming sales process.

Cerulli said asset managers could gain significant insights by viewing these attributes of the individual distribution channels that are advising the clients. For example, asset managers rank RIAs as the most attractive channel for HNW clients.

Most RIAs, as well as multifamily offices, rely on third-party managers. Because they are autonomous and embrace open architecture, they are highly accommodating providers for cutting-edge products such as hedge funds.

Bank trusts represent the longest holding periods, but asset managers view them as conservative providers and do not like the lengthy sales process that averages 10 months.

The big wirehouses are an anomaly. With their immense scale, scope of services and huge advisor force, they dominate the overall HNW market both in assets and market share and are expected to uphold control, Cerulli said.

Their advisors distribute the largest percentage of HNW assets to mutual funds and separate accounts compared with other channels. And thanks to their internal resources, they represent the fastest timeframe in winning an HNW account at an average of just five months.

However, the wirehouses are only the fourth-most attractive HNW channel for asset managers. Cerulli attributed this to the surge of RIAs and MFOs, bank trusts increasingly adopting open architecture and the fact that wirehouses are well known for leveraging their influence on required revenue sharing.

Cerulli said 2013 marked the first year it had presented state trusts as their own unique channel.

For asset managers, the majority of these banking organizations are nimbler and more technologically savvy than their nationally registered counterparts. As well, these firms tend to be more reliant on third-party managers and products because they lack the resources for proprietary funds.

At the same time, the study found, efficiently wholesaling into these firms may be a challenge owing to their private nature and scattered locations.

Cerulli expected state-registered trusts to continue to grow as more wealth managers and investors take advantage of states vying for the business via lax state laws and taxation.

It projected that the state-registered entities would post asset growth of more than 8% over the next 3.5 years, outpacing the growth of both nationally registered bank trusts and private client groups.

Fee Compression

Cerulli’s data showed that nearly three-quarters of HNW providers remained committed to their “stated fee schedules” during the past three years, while the remaining one-quarter reported an increase.

However, Cerulli said that despite the actions taken over the past three years, major differences existed between HNW providers’ stated fees and those they actually imposed.

Given the intensifying competition for HNW assets, a client’s investable assets continued to be the pivotal element in determining fees, according to the report. Approximately three-quarters of HNW providers said their minimum fee was 1%, if not greater, while only 18% reported a minimum between 50 and 99 basis points.

In reality, discounting among HNW wealth managers remains rampant, the report said. On average, they impose a fee of just 51 basis points on all investors with more than $5 million in investable assets.

Cerulli reported that, on average, bank trust organizations were imposing among the lowest stated fees. This was especially true for clients investing between $25 million and $50 million.